What is Yield?
Yield is a measure of how much money you might stand to earn on an investment over a set period of time, usually expressed as a percentage — in some cases, yield can also be negative.
🤔 Understanding yield
How do you know whether an investment is worth it? One thing that can help you figure this out is calculating the yield. This is a measure of how much income you can expect to earn on an investment over a set period of time, usually a year, expressed as a percentage. Investors can calculate the yield on stocks, bonds, real estate, savings accounts, and other assets. Knowing this figure can help them estimate how much cash the investment may generate over time and to compare different investment options. The formula for each kind of investment is a bit different. Generally speaking, they take the income you receive from the investment and divide it by the investment value (the cost you paid or current market value).
Imagine your parents offer to buy you an apartment under one condition: You get a roommate and charge enough rent so the apartment produces income rather than costs your parents’ money. Assume your parents pay $250,000 for the apartment and tell you they want a 5% yield.
Let’s say you find a roommate and charge her $2,000 in rent. Is that enough to produce the yield your parents want? To calculate the yield for real estate, you need to know the cost of the property and the net rental income (rent minus expenses, such as taxes). If your parents tell you they pay $3,000 a year for taxes and other expenses, the net rental income is ($2000 * 12) - $3000 = $21,000. Divide that number by the real estate value of $250,000, then multiply by 100 to get a net yield of 8.4%. This more than meets your parents’ demands.
Think of yield as a way to measure your harvest...
If you plant 100 seeds on one plot of land and get 10 plants, and you plant 100 different seeds on another equivalent plot and get 50 plants, the second variety has a higher yield. Similarly, measuring the yield of investments can help you compare how much you can expect to get back (or harvest) depending on where you put your money.
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What are the different types of yields?
Different formulas exist for calculating yield for stocks, bonds, real estate, and other investments. The most common are:
- Dividend yield (also called stock investment yield), which lets you compare the dividends a company pays to its stock price.
- Bond yield, which shows what an investor can earn by buying and redeeming a bond.
- Real estate yield, which tells investors how much they stand to earn on a property investment compared to its value.
- Percentage yield, a catch-all formula for generic investments.
Yield calculations based on fluctuating information (such as stock price) are called “anticipated yields,” since they’re not guaranteed. Those based on fixed values are called “known yields,” because the information in the formula is already determined.
How is yield calculated?
Annual dividends per share ÷ Stock price
You can typically find annual or quarterly dividends per share listed on a company’s financial statements. If not, divide the total dividends paid by the number of outstanding shares.
Assume you own stock that trades at $100 per share. The company paid $2 per share in dividends last year. The dividend yield is then: Annual dividends per share ÷ Stock price = $2 ÷ $100 = 2%.
A higher dividend yield may indicate that a company is financially healthy, but not always. Falling stock prices can artificially inflate the yield, meaning the figure will appear high even though the company may be in trouble.
Bond yield This formula gives investors one way to compare the returns on different bonds:
Annual coupon payment ÷ Bond face value
Annual coupon payment is the interest the bondholder gets each year from the issuer. Bond face value is the bond’s price when it was issued. Assume a $2,000 face value, annual coupon payments of $100, and bond price of $1,500. The bond yield would be Annual coupon payment ÷ Bond face value = $100 ÷ $2,000 = 5%.
In some unusual cases, bond yield can be negative. When this happens, those who issue debt are paid to borrow, while bond buyers pay cash or a cash equivalent instead of receiving interest on their investment.
Real estate yield Real estate yield, or net rental yield, can help investors compare how much profit a certain property will generate compared to others:
Net rental income ÷ Real estate value
Net rental income is the annual rent minus annual expenses, such as taxes and upkeep. Real estate value refers to how much the property is worth today, not the purchase price. Assume you own a home you rent out for $36,000 a year after expenses. If the current value of the rental property is $350,000, then the yield is Net rental income ÷ Real estate value = $36,000 ÷ $350,000 = 10.2%.
Percentage yield Percentage yield is an all-purpose formula to calculate the yield of an investment when a more specific one doesn’t exist:
Income ÷ Value
For example, income can be interest received and value can be the total balance in an account. If you receive $5 in interest from the bank per year on a savings account of $250, the yield is Income ÷ Value = $5 ÷ $250 = 2%.
Formulas that take into account compound interest (interest earned on interest), such as annual percentage yield (APY) — commonly used for checking and savings accounts — can include far more variables.
What is the difference between current yield vs. yield to maturity?
Current yield and yield to maturity are other ways of calculating yields for bond investments. Current yield (also known as coupon yield) is a relatively simple formula based on a bond’s interest payment (annual coupon payment) compared to the bond’s current price. It shows a snapshot of income earned on the bond:
Current yield = Annual coupon payment ÷ Bond price
Yield to maturity is a more robust formula that captures the total return you can expect on a bond if you hold it until it matures (when the final payment is due). The calculation assumes that you buy the bond at the current price and all payments are made on time. Even though the formula takes the long term into account, the rate is in annual terms. Here’s the formula:
What are yields vs. returns?
Returns are gains or losses on an investment or venture, usually expressed in dollars. Returns generally refer to the money you made or lost on an investment in the past. Meanwhile, yield typically shows the income you stand to earn in the future while holding the investment, expressed as a percentage, usually on an annual basis.
For example, if you purchase a stock for $5 and sell it for $10, your return is $5. If you also receive a dividend payment of $1 while you own the stock, then the total return is $6. The dividend yield for the same investment would be Annual dividends per share/Stock price or $1/$5, which comes out to 20%.
Rate of return sits between return and yield: It expresses your net gain or loss on an investment as a percentage of what you originally paid for it. The formula is:
For this stock, the rate of return would be (($10 - $5) ÷ $5) x 100, or 100%.
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